Wednesday, February 8, 2012

The Wall Street Journal reports today that an Apple letter, "dated Nov. 11 but not previously disclosed", proposed to the European Telecommunications Standards Institute (ETSI) to set basic rules for FRAND licensing of standard-essential patents. I have obtained a copy of the letter (as always, I protect my sources). Here's the letter, which I'll explain further below:

Apple's letter then moves on to propose a solution based on three specific principles: appropriate royalty rate; common royalty base; no injunction.

Before I elaborate on the three pillars of Apple's proposal one by one, I want to stress that this approach to FRAND -- giving meaning to the term -- is the one that Google should also adopt. What became known yesterday is that Google just says it's going to do FRAND licensing. That is, by far, not enough, as I explained. Google obviously wouldn't say that it's not going to do FRAND licensing -- if it said so, it would, conversely, describe itself as unfair and unreasonable, and I've never seen anyone do that.

The problem with unreasonable people or companies is never that they want to be unreasonable by their own standards. It's always that they have a distorted coordinate system within which they consider something reasonable that truly reasonable people consider unreasonable. That's why it's meaningless to promise reasonableness without particularity.

Now let's talk more specifically about the three pillars of Apple's proposed framework:

Appropriate Royalty Rate:

Apple's letter defines an appropriate rate as one that is reflective of the [particular patent holder]'s portfolio of cellular standards essential patents and patent applications as compared to the total, industry-wide pool of such patents and applications". Apple wants parties to bear this in mind when they make their initial offer but also with a view to "the final terms of any license". As far as initial offers are concerned, Motorola's demand of a 2.25% royalty on Apple's 3G-capable products is an example (not mentioned explicitly in Apple's letter) of an excessive rate considering that there are so many other patents on 3G/UMTS and related standards. Samsung's 2.4% demand is another example.

Common Royalty Base:

This point here is a very important one and often overlooked when people talk about royalties. It's not just what percentage someone asks for -- it's just as much about what base a given percentage is applied against.

Actually, I've seen pretty good analogies and metaphors on some online discussion boards. Let's assume BMW builds a 50,000 euro car that comes with a built-in UMTS-capable computer system. Now let's take Motorola's 2.25% royalty demand as an example. What is it they want to get 2.25% of? The entire car? That would be more than 1,000 euros for a few wireless patents. The computer system? Or wouldn't it actually make sense to multiply that percentage just with the cost of the baseband chip, the component that provides basic telecommunications functionality and is sold at a per-unit price between $10 and $15 including all of the relevant patent rights?

Apple's letter proposes the latter: "This common base, as between two negotiating parties, should be no higher than the industry average sales price for a basic communications device that is capable of both voice and data communications."

Another nice way to put it that I found on a discussion board: if you buy a carpet and place furniture and even more valuable products on top of that carpet, does that mean that you should have to pay more for the carpet? Obviously not. In the same way, a smartphone or tablet computer has most of its value above the baseband layer.

But Motorola and Samsung ask for royalties based on the entire market value of the final product. They use the broadest possible royalty base. Samsung's demand for 2.4% of the entire market value of Apple's products was stated in a public decision by an Italian court. Motorola's demand of 2.25% of the entire market value of Apple's as well as Microsoft's products is also well-documented, such as in a lawsuit that Microsoft brought back in 2010 to allege Motorola's failure to honor its FRAND licensing obligations. For its video codec patents, Motorola wants to receive a percentage of the final product, such as an entire Xbox gaming console or an entire PC.

One cannot overstate the importance of the royalty base issue.

No Injunction:

With recent developments, everyone understands the problem that injunctions based on standard-essential patents pose. I also addressed this in a recent blog post, entitled "Will Google break or save the Internet?"

I agree with Apple that "[s]eeking an injunction would be a violation of the party's commitment to FRAND licensing".

Finally, Apple's letter contains some interesting information on Apple's own "patents and patent applications that may be or may become essential to LTE, UMTS, EDGE, GPRS, and GSM". Apple's letter refers to 140 such assets. Some of those were filed for by Apple itself, while others were acquired from third parties.

For such an interesting letter, it took amazingly long to leak.

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About Me

Florian Mueller is an app developer who used to be an award-winning intellectual property activist. His 30 years of software industry expertise span different market segments (games, education, productivity and infrastructure software), diverse business models, and technical and commercial areas of responsibility. In recent years, Florian advised a diversity of clients on the patent wars surrounding mobile devices, and on their economic and technical implications. (In order to avoid conflicts of interest, Florian does not hold or initiate transactions in any technology stocks or derivatives thereof, except that he is long AAPL.) He is now developing games for smartphones and tablet computers.